FHA vs. Conventional Loans: Which One’s Right for You?

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FHA loans and conventional loans are popular options among homebuyers. FHA loans come with more relaxed credit score requirements, while conventional loans allow you to forgo mortgage insurance if you have a high enough down payment.

Here are the key differences between FHA and conventional loans:

• Credit score requirements
• Debt-to-income requirements
• Down payment
• Loan limits
• Mortgage insurance
• Property restrictions

Comparing FHA and conventional loans

An FHA loan is backed by the Federal Housing Administration and protects the lender if the borrower defaults. An FHA loan also:

• Requires a credit score of at least 500
• Requires mortgage insurance premiums (MIPs), regardless of your credit score or down payment amount
• Helps people who otherwise wouldn’t qualify for home financing

A conventional loan is the most common type of mortgage, but it has no government guarantee. A conventional loan also:

• Requires a credit score of at least 620
• Requires you to buy private mortgage insurance (PMI) if you place less than 20% down
• Can have less costly PMI payments compared to FHA mortgage insurance

Here’s a quick look at how FHA loans and conventional loans compare:

The differences between FHA and conventional loans

FHA loans have more relaxed financial standards but stricter property standards and mortgage insurance requirements. Conventional loans, on the other hand, have stricter financial standards but more relaxed property standards and mortgage insurance guidelines.

Credit score requirements

FHA loans

Credit score standards are generally less stringent for FHA loans than for conventional loans. You only need a credit score of 580 to qualify with 3.5% down. If your credit score is 500 to 579, FHA loan guidelines require you to put 10% down.

Conventional loans

Conventional loans often require a credit score of at least 620, but as with FHA loans, some lenders may require a higher score. The higher your credit score, the better your interest rate is likely to be.

Here’s how a good credit score can affect mortgage rates:

Wondering what you might qualify for? Credible offers a fast, easy way to compare prequalified mortgage rates. While Credible doesn’t offer FHA loans, you can get quotes for conventional loans from multiple lenders without impacting your credit score.

Debt-to-income requirements

Your debt-to-income ratio, or DTI, is a percentage that tells lenders how much of your total monthly income goes toward debt payments such as your car loan and student loan.

Here’s how to calculate your DTI:

(Total monthly debt) / (Gross monthly income) x 100 = DTI

FHA loans have less stringent standards than conventional loans when it comes to DTI.

Down payment

There’s a common misconception that if you need a low-down-payment loan, you’ll have to get an FHA loan. In reality, you can get a conventional loan with as little as 3% down.

FHA loans

As mentioned before, if your credit score is at least 580, you can put down as little as 3.5% on an FHA loan. If your credit score is 500 to 579, you’ll have to put down at least 10%.

Let’s say you’re buying a home that costs $225,000. If you put down 3.5%, you’ll need $7,875. If you put down 10%, you’ll need $22,500.

Conventional loans

Putting 20% down on a conventional loan will reduce your monthly payment and allow you to forgo PMI, but you can potentially put down as little as 3%. On a $225,000 loan, that would amount to $7,750, even less than what you’d need for an FHA loan.

Loan limits

The loan limit for both FHA loans and conventional loans vary depending on where you live. The FHA loan limit is substantially lower almost everywhere, however. How much you can borrow will also depend on what you can afford with your income and debt, so you may not be able to borrow up to the loan limit for your area.

FHA loan

For single-family homes, the 2021 loan limit for FHA loans in low-cost areas is:

• $356,362 in most low-cost areas
• $822,375 in most high-cost areas

An exception exists for Hawaii, Alaska, Guam, and the U.S. Virgin Islands, where single-family buyers can borrow up to $1,233,550. These limits can change from year to year.

Conventional loan

If you’re getting a conventional loan, you can’t borrow more than the conforming loan limit, which is:

• $548,250 in most areas
• $822,375 in certain high-cost areas, including Hawaii, Alaska, Guam, and the U.S. Virgin Islands.

Again, these are the limits for single-family homes, and the limits can change each year.

If you want to borrow more than the conforming loan limit and have the income to support it, you’ll need to shop for a jumbo loan. These loans require a larger down payment and stronger credit.

Mortgage insurance

Mortgage insurance protects the lender if you can’t make your monthly payments. Both FHA loans and conventional loans have mortgage insurance, but their differences are significant.

FHA loans

Mortgage insurance premiums are mandatory for FHA loans regardless of how much you put down. The two premiums you’ll encounter are:

• Upfront mortgage insurance premium: Every borrower pays this. It’s 1.75% of the loan amount, and you can roll it into your loan.
• Annual mortgage insurance premium: If you put down 10% or more, you’ll pay mortgage insurance premiums for 11 years. If you put down less than 10%, you’ll pay MIPs for the life of your loan, usually 15 or 30 years.

How much does the annual mortgage insurance premium cost? It depends on your loan term, down payment, and loan amount.

If you get an FHA loan, it’s possible to refinance into a conventional loan down the road to eliminate mortgage insurance once you have 20% equity. But keep in mind you’ll have to pay closing costs on your new loan, and home values and interest rates may change unfavorably over that time.

Conventional loans

With a conventional loan, you’ll need to pay PMI if you don’t put at least 20% down. As with an FHA loan, the cost will depend on your loan term, down payment, and loan amount. Your credit score and loan type are also a factor.

Let’s again use a $225,000 purchase price for our example and consider the low and high ends of what private mortgage insurance could cost on a 30-year, fixed-rate mortgage.

• High end: 3% down payment, 660 credit score: 1.50% annual premium, $272.81 monthly payment
• Low end: 15% down payment, 760 credit score: 0.19% annual premium, $30.28 monthly payment

Property restrictions

FHA loans have more restrictions than conventional loans when it comes to the property itself. Not only are FHA loans limited to primary residences, they also come with more explicit standards for the property’s condition.

FHA loans

An FHA loan will require a home appraisal. The appraiser must follow strict requirements from the FHA to evaluate whether the property is safe, sound, and secure.

Here are a few standards the property must meet:

• Proper site drainage
• Safe drinking water
• Safe and comfortable heating
• Watertight roof with at least two years of life left

Learn More: FHA Approved Condos: How to Find One

Conventional loans

Conventional loans can be used for second homes, rental homes, and houses to be flipped, as well as for primary residences. A home purchased with a conventional loan must also be safe, sound, and secure.

When FHA loans make sense

FHA loans are best for borrowers with lower credit scores and higher debt-to-income ratios who want to pursue homeownership now rather than waiting until their credit, debt, or income improve. This might sound like you if you’re a first-time homebuyer.

People aren’t robots, and we don’t buy homes purely based on financial analysis. Personal circumstances can make homeownership more appealing than renting even if you can’t get an ideal mortgage.

Learn More: Programs for First-Time Homebuyers

When conventional loans make sense

Because they’ll generally be cheaper in the long run, conventional loans are best for borrowers with higher credit scores and lower debt-to-income ratios.

Which loan option might be best for you?

About the author

Amy Fontinelle

Amy Fontinelle is a mortgage and credit card authority and a contributor to Credible. Her work has appeared in Forbes Advisor, The Motley Fool, Investopedia, International Business Times, MassMutual, and more.

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